On June 21 the U.S. Supreme Court reversed prior case law and let states tax online retailers that do not have physical presence in the state. The ruling also has significant implications for franchise systems that sell products and franchise their brands in multiple states.

Online retailers Wayfair, Overstock.com, and Newegg do not have a physical presence in South Dakota. They challenged a South Dakota law that requires out-of-state retailers to collect and pay sales tax “as if they had a physical presence in the state.” The Court’s precedent held that whether an out-of-state seller had to collect and pay taxes on sales to the state’s consumers depended on whether the Seller had a physical presence in the state. The Court upheld state taxes if they: 1) apply to an activity with a substantial nexus with the taxing state, 2) are fairly apportioned, 3) do not discriminate against interstate commerce, and 4) are fairly related to the services the state provides.

The new decision ruled that physical presence is not necessary. Now the “closely related” requirement applies. The Court acknowledged that requiring physical presence amounted to a judicially created tax shelter. It let businesses operate without physical presence in as many states as feasible to avoid taxes. The Court ruled this was unconstitutionally arbitrary as it treated identical economic actors differently.

Next, the Court said that in today’s economy, virtual presences should be subject to the same sales tax for the same items. Finally, the Court explained that the physical presence requirement was a burden on states’ ability to collect taxes and fund public functions and it put an unfair tax burden on consumers who bought goods in their state. The Court ruled that it was a mistake to give online retailers an arbitrary advantage over competitors that must collect sales tax from consumers. The Court ruled that the South Dakota law did require a substantial nexus before making out-of-state retailers liable for collecting and paying state sales tax.

This decision could lead to states taxing franchisors on royalties from out-of-state franchisees, for the use of marks and intellectual property. This could be a significant financial burden for franchise systems. Franchisors should consult their franchise and tax attorneys on the potential implications of this decision and assess what modifications to their business model and franchise agreements may reduce the impact of the decision. Franchisors might also rethink their e-commerce platforms with regard to granting or withholding rights to franchisees to sell goods out-of-state.

Read: South Dakota vs. WayFair, Inc., et al.